ACS4778 Rev
Ukraine
Opportunities and Challenges
for Private Sector Development
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2
Contents
List of Tables:����������������������������������������������������������������������������������������������������������������������������������������������4
List of Figures:��������������������������������������������������������������������������������������������������������������������������������������������5
List of Acronyms�����������������������������������������������������������������������������������������������������������������������������������������8
Acknowledgments���������������������������������������������������������������������������������������������������������������������������������������9
Executive Summary����������������������������������������������������������������������������������������������������������������������������������10
Chapter I: The Private Sector Growth Problem������������������������������������������������������������������������������������17
Chapter II: The Regulatory Environment����������������������������������������������������������������������������������������������32
Chapter III: Access to Finance����������������������������������������������������������������������������������������������������������������48
Chapter IV: Competition��������������������������������������������������������������������������������������������������������������������������68
Concluding Remarks��������������������������������������������������������������������������������������������������������������������������������83
Annex 1������������������������������������������������������������������������������������������������������������������������������������������������������85
Annex 2������������������������������������������������������������������������������������������������������������������������������������������������������94
Annex 3������������������������������������������������������������������������������������������������������������������������������������������������������96
Annex 4������������������������������������������������������������������������������������������������������������������������������������������������������98
References������������������������������������������������������������������������������������������������������������������������������������������������102
3
List of Tables:
Table 1: Key Policy Recommendations: Regulation, Access to Finance and Competition�������������14
Table 2: Twenty Five Largest Companies in Ukraine, by Revenue, 2012���������������������������������������28
Table 3: Penalties Imposed and Collected Under the Competition Law
and Unfair Competition Law���������������������������������������������������������������������������������������������80
4
List of Figures:
Figure 1: GDP Growth in Ukraine and ECA, 1990-2013, 1990=100�����������������������������������������������18
Figure 2: GDP per Capita in PPP, Constant 2005 International $�����������������������������������������������������18
Figure 3: Real GDP Growth Rate, 2008-2013�����������������������������������������������������������������������������������19
Figure 4: Labor Productivity Growth in Ukraine and Selected Countries, 1996-2011���������������������20
Figure 5: GDP per Person Employed, US=100, 2012�����������������������������������������������������������������������20
Figure 6: Total Factor Productivity Growth, 1996-2010�������������������������������������������������������������������21
Figure 7: Total Factor Productivity Levels Relative to the Global Production Frontier, 2010���������21
Figure 8: Ukraine’s Labor Productivity by Sector, 2002-2008���������������������������������������������������������22
Figure 9: Country Comparison of Labor Productivity by Sector������������������������������������������������������23
Figure 10: Industrial Production in Ukraine and Global Metal Prices������������������������������������������������24
Figure 11: Top 10 Items in Export Baskets in Ukraine and Poland, 1995 and 2010���������������������������24
Figure 12: Top 10 Destinations for Ukrainian and Polish Exports, 1995/2002 and 2010�������������������25
Figure 13: Ukraine’s Share of World Exports Relative to Peers, 1995-2011��������������������������������������26
Figure 14: Export Sophistication in Ukraine and Poland (EXPY Index)��������������������������������������������26
Figure 15: Revealed Comparative Advantages of Ukrainian Exports, by Leamer Category��������������27
Figure 16: SME Sector Contribution to Employment and GDP: Ukraine and Selected Countries��������28
Figure 17: Ukraine’s Energy Efficiency Relative to Peers������������������������������������������������������������������29
Figure 18: Cumulative FDI Inflows to Ukraine and Regional Peers, 1992-2011��������������������������������30
Figure 19: FDI Inflows to Ukraine, 1995-2012, in $ Million��������������������������������������������������������������30
Figure 20: Price Competitiveness Indicators in Ukraine, 2005-2011��������������������������������������������������31
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Figure 21: Ukraine’s Performance in the Doing Business Ranking, 2005-2013���������������������������������34
Figure 22: Ukraine’s Position in the 2014 Doing Business Ranking��������������������������������������������������35
Figure 23: Most Problematic Business Regulations in Ukraine According
to the 2014 Doing Business Ranking (189 countries Worldwide)�������������������������������������35
Figure 24: Ukraine and Regional Peers in International Rankings�����������������������������������������������������36
Figure 25: Ukraine, the Most “Repressed Economy” in Europe
According to the 2013 Economic Freedom Index (EFI)����������������������������������������������������37
Figure 26: Direct Cost of Complying with Permits, Inspections, and Technical Regulations������������38
Figure 27: Governance Data for Ukraine and Regional Peers,
Based on the Kaufmann Index, 1996-2011������������������������������������������������������������������������40
Figure 28: Strength of Market Institutions and Production Efficiency������������������������������������������������41
Figure 29: Percentage of Enterprises Resorting to Unofficial Ways of
Solving Problems with State Authorities, 2008 and 2010��������������������������������������������������42
Figure 30: Index of the Share of Firms Affected by State Capture, 2000�������������������������������������������44
Figure 31: Strategies Addressing State Capture and Corruption���������������������������������������������������������45
Figure 32: Financial Sector Depth in Ukraine Relative to Peers, 2011�����������������������������������������������49
Figure 33: SME Lending in Ukraine Relative to Selected Peers, 2011�����������������������������������������������49
Figure 34: Main Challenges to Doing Business in Ukraine, GCR 2013-2014������������������������������������50
Figure 35: Percentage of Firms Identifying Access to Finance as a Major Constraint�����������������������50
Figure 36: National Bank of Ukraine 1Q2013 Enterprise Survey Results: Access to Finance�����������51
Figure 37: NBU Enterprise Survey Results, 1Q2009-1Q2013������������������������������������������������������������52
Figure 38: Banking Sector Coverage���������������������������������������������������������������������������������������������������53
Figure 39: Use of Banking Services by Companies����������������������������������������������������������������������������53
Figure 40: Banking Market Concentration in Selected Countries, 2010 (in Percent)�������������������������54
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Figure 41: Peer Countries’ Banking Sector ROE and CAR, 2012 (in Percent)�����������������������������������54
Figure 42: Interest Rates and Inflation, 2007-2012�����������������������������������������������������������������������������56
Figure 43: Shares of Short-term Loans and Deposits in Total Loans and Deposits����������������������������57
Figure 44: Portfolio Composition by Bank Ownership, 2012YE��������������������������������������������������������58
Figure 45: Ownership Structure of the Banking Sector, 2003-2012, in Percent of Total Assets���������59
Figure 46: Credit Information: Ukraine and Regional Peers, 2013�����������������������������������������������������60
Figure 47: Enforcing Contracts in Ukraine and Peer Countries, 2013������������������������������������������������61
Figure 48: Effective Interest Rates for SME Loans, Range and Average (August 2013)�������������������64
Figure 49: Local Hryvnia Debt of Private vs. Public Sector���������������������������������������������������������������65
Figure 50: Stock Market Capitalization, Ukraine and Peer Countries, 2002-2011�����������������������������65
Figure 51: Stock Market Turnover, Ukraine and Peer Countries, 2002-2011�������������������������������������66
Figure 52: Ukraine’s Performance on Competition Elements of the GCR, 2006-2013����������������������70
Figure 53: Indicators of Market Competition and Competition Policy�����������������������������������������������70
Figure 54: Measures of Firm Concentration in Ukrainian Manufacturing Sectors�����������������������������71
Figure 55: Market Structure in Manufacturing Sectors, 2009�������������������������������������������������������������71
Figure 56: Market Structure as Calculated by AMC, 2004-2011��������������������������������������������������������72
Figure 57: Budgetary Subsidies and Current Transfers to Enterprises (in Percent of GDP)���������������76
7
List of Acronyms
EU – European Union
GDP – Gross Domestic Product
ECA – Europe and Central Asia
SME – Small and Medium Enterprise
OECD – Organization for Economic Cooperation and Development
NGO – Nongovernmental Organization
RIA – Regulatory Impact Assessment
ICT – Information and Communication Technologies
NPL – Non Performing Loans
AMC – Anti-Monopoly Committee
AA – Association Agreement
DCFTA – Deep and Comprehensive Free Trade Area
IMF – International Monetary Fund
TFP – Total Factor Productivity
SOE – State Owned Enterprise
DB – Doing Business
EBA – European Business Association
CEO – Chief Executive Officer
CPI – Corruption Perception Index
WTO – World Trade Organization
EFI – Economic Freedom Index
IFC – International Financial Corporation
SES – State Sanitary Service
EC – European Commission
EBRD – European Bank for Reconstruction and Development
NBU – National Bank of Ukraine
CEE – Central and East Europe
M&A – Mergers and Acquisitions
FX – Foreign Exchange
IFI – International Financial Institution
FDI – Foreign Direct Investment
IPO – Initial Public Offering
ICN – International Competition Network
CEM – Country Economic Memorandum
GCR – Global Competitiveness Report
US – United States
CIS – Commonwealth of Independent States
8
Acknowledgments
This report was prepared by a team led by Marcin Piatkowski, and comprised of Melissa A. Rekas, Colleen
Mascenik, Yevhen Hrebeniuk, and Serhiy Osavolyuk. Kristina Mikulova, Inna Pidluska, Alina Tourkova,
and Mariana de Ioottyde Paiva Dias made additional contributions.
The team benefited from the guidance and advice of Qimiao Fan, Paloma Anos Casero, Alexander Pankov,
and four peer reviewers: Ruslan Pionktivskiy, Donato de Rosa and Marius Vismantas of the World Bank,
and Jose Roman Leon Lora of the European Commission’s Delegation to Ukraine.
9
Executive Summary
1. Ukraine has untapped growth potential. Ukraine has fertile agricultural land, an attractive
geographical location in Europe, bordering the European Union (the largest market in the world with a
GDP of almost $17 trillion), and a large domestic market of almost 46 million consumers. It also has
abundant natural resources, relatively well-developed infrastructure, high quality human capital, and a
significant industrial base.
2. However, Ukraine’s potential has yet to be adequately harnessed. Defying expectations at
the time of the collapse of the Soviet Union, when hopes that the newly found independence would spur
Ukraine’s development loomed large, the country’s GDP per capita still lingers below 1989 levels and at
a mere 10 percent of the European Union average after twenty years of transition. Incomes have increased
much more slowly in Ukraine than in the Europe and Central Asia (ECA) region as a whole. Ukraine has also
been under performing relative to regional peers, such as Poland, Romania, Russia and Belarus, especially
during the recent global crisis, registering a decline in GDP by 15 percent in 2009. Despite similar starting
points at the beginning of transition, Poland’s and Ukraine’s income levels, for instance, have diverged over
the years: income per capita in Poland is now almost four times higher than in Ukraine. Growth projections
suggest that the income gap between Ukraine and its peers will not be closed in the short term.
3. This note argues that the stunted growth of the private sector goes a long way in explaining
Ukraine’s poor growth performance. The tepid private sector growth is reflected in (i) the stagnant
structure of the country’s industry and exports, where old industries such as steel, machine-building and
chemicals continue to dominate. They operate at low levels of industrial productivity, which has grown
at a much slower pace than in peer countries in the last decade. There is also (ii) the low inflow of high
value-added FDI, especially in export-oriented manufacturing and (iii) the relatively limited role of SMEs
in developing the economy. All these factors suggest that the market-driven process of entrepreneurship,
innovation, and productivity does not seem to work properly, and thus undermines Ukraine’s growth
prospects.
4. This note identifies weaknesses in the regulatory environment, limited access to financing,
and lack of competition as the main constraints to private sector development, and offers short- and
medium-term policy reform options. The analysis offers evidence based on a stock-taking of existing
research produced by the World Bank and external partners – such as the European Commission and the
OECD – as well as on discussions with members of the Ukrainian government, business associations,
NGOs, and academia. The poor regulatory environment, including tax administration, property rights,
permits, certification and inspections, limited access to finance and low levels of overall competition pose
obstacles to private sector development, undercutting Ukraine’s growth prospects. It finds that there is
scope for reforms and provides a list of policy recommendations.
5. On the regulatory environment, the note argues that despite recent progress, Ukraine
continues to suffer from excessive red tape, poor implementation of business regulations, and weak
public sector governance. The note offers recommendations on how to overcome these obstacles, and move
ahead with reforming business regulations. The recommended reforms include: (i) full implementation of
measures aimed at improving the business climate, proposed in the President’s “2013 National Action
Plan”; (ii) wholesale reduction of the number of permits and licenses through the introduction of a full
regulatory guillotine exercise based on international good practice and building on the previous, partially
successful effort in 2005; (iii) fundamental strengthening of the regulatory impact assessment (RIA) of new
legislation (that is, some measure of the expected impact on the cost of doing business); (iv) completion
of a risk-based system of inspections, (iv) elimination of outdated standards and technical regulations;
(v) adoption of EU regulations, especially in areas such as food safety and technical regulations; (vi)
effective implementation of the new insolvency law, and (vii) broad introduction of e-government and
10
ICT solutions to increase transparency and reduce scope for graft. The note also recommends that aside
from improving primary and secondary legislation, mostly by harmonizing it with the EU standards,
the Government should emphasize the efficient implementation of regulations, as it often lags behind
legislation. Consistent, impartial, and efficient implementation of regulations offer substantial “quick
wins” for the business environment. Coupled with better governance and committed political leadership,
these reforms could play a key role in facilitating a decisive break from the legacy of the Soviet past.
6. As for access to finance, despite significant outstanding corporate borrowing, access to
finance remains limited, especially for SMEs. This is for a number of reasons. First, prohibitively high
interest rates, driven mainly by the central bank’s commitment to maintaining a de facto pegged exchange
rate, combined with government’s large borrowing needs that crowd out lending to the private sector,
represent a material obstacle to getting credit. Second, lax supervision over related-party lending supports
the dominance of the banking sector by a few, locally-controlled business groups, which tend to distribute
credit only within their groups rather to the whole economy. Third, access to credit is hindered by the ongoing
withdrawal of foreign banks, increased post-crisis risk aversion, and the large number of non-performing
loans. Fourth,credit is scarce due to limited access to long-term funding, a weak enforcement environment
characterized by inadequate judicial practices, and a fragmented credit information infrastructure that does
not support sound credit risk management. Finally, access to finance is undermined by the underdeveloped
non-bank and capital markets. Enhancing access to credit, which is critical for financing the private sector,
requires a coordinated approach to address inter-related challenges of transitioning to a flexible exchange
rate, supporting the growth of long-term deposits, enforcing legislation on the disclosure of the ultimate
beneficiaries of banks, identifying and limiting related party lending, removing tax disincentives for NPL
transfers and write-offs, and consolidating information on credit histories. The development of the capital
markets needs to be supported by enhanced market transparency, higher disclosure requirements, and
improved reporting standards and corporate governance.
7. On competition, this note argues that low levels of competition on Ukraine’s domestic markets
are restricting the country’s economic growth and potential. Many sectors exhibit a high concentration
of firms and low rates of firm entry and exit. The effectiveness of competition policy is weak. This is
problematic because the degree of competition in an economy has a direct impact on productivity, growth,
and consumer welfare. Competition problems in Ukraine are driven by barriers to market entry and exit,
created and supported by excessive red tape, weaknesses in the national competition policy framework,
and the often ineffective application of competition policies. The Anti-Monopoly Committee (AMC), the
competition watchdog, is supported by a relatively strong legal framework–though challenges such as the
lack of investigative power remain – but the main challenge is the inefficient application of the law. It is
reflected in the fact, for instance, that less than 10 percent of fines imposed by the AMC are actually paid,
or that merger and cartel control is often difficult if not impossible without knowledge of the ultimate
owners of companies involved. Going forward, enhancing competition to encourage market entry and
promote private sector growth would be supported by fully harmonizing Ukrainian legislation with that of
the European Union as well as implementing the National Competition Program 2014-2020, thus boosting
the AMC’s investigative power, and providing adequate resources to ensure that the AMC can maintain
high standards of performance and accomplish its mission. Moreover, enhanced competition would require
better-trained judges adjudicating competition cases, truly competitive public procurement and non-
distortionary state aid, and stronger awareness and involvement of the civil society. Finally, ensuring the
AMC’s independence and clear mandate to go after all transgressors will be decisive.
8. On a more general level though, private sector will not fulfill its potential without progress
in fighting state capture and corruption. These issues have an across-the-board impact on the business
environment, and they represent the main underlying cause for the stunted growth of Ukraine’s private
sector, the undiversified structure of the economy and its exports, and the low productivity and uneven
11
pace of reforms. While Ukraine has made a lot of progress on harmonizing legislation with EU standards,
the regulatory framework continues to be patchy, unpredictable and business-unfriendly, reflecting the
influence of business lobbies, rent-seeking and an ossified public administration, which benefits from the
status quo. The application of policies is, in turn, mired in a culture of legal relativism, where the meaning
of the law is subject to an ongoing re-interpretation depending on the play of various interests at the
national, regional and even local level. On top of that, corruption is pervasive, and it is perceived as much
more than a usual cost of doing business.
9. There are a number of ways of reducing state capture and corruption. State capture in Ukraine
is reflected in the adverse influence of selected vested interests on public policy at the cost of the society at
large. It is rooted in the country’s political culture, built upon an old model of fused political and economic
power, a non-transparent and non-competitive privatization process (which allowed for the accumulation
of large economic assets in the hands of only a few and largely excluded international investors), murky
public procurement and state aid. In addition, a partial, dependent and unreliable judiciary impels business
elites to resort to wielding direct influence over the legislative process and the state apparatus to secure
property rights. Given this background, reducing state capture will require the full transparency of the
legislative process for all new regulations, strengthening regulatory impact assessments, and expanding the
involvement of the business sector, trade unions, NGOs and society in the legislative process. In addition,
state capture and corruption canbe mitigated by installing a fully transparent public procurement and state
aid system, which would allow for full access to information on every Hryvnia spent from public money,
public hearings on the tender criteria in large public contracts, and public monitoring of the bidding process
itself. Transparent and competitive appointments of officials in public administration and state-owned
enterprises would also be helpful. Opening up to competition, especially from foreign companies, could
weaken special interests by forcing them to compete on more equal terms and by lowering rents.
10. A fundamental reform of the judicial system would also be a critical step towards reducing
state capture. Economies can hardly develop without secure property rights safeguarded by impartial and
independent courts. While this topic falls outside the scope of this note, it is clear that an independent,
impartial, and professional judicial system would provide the much needed recourse for the private sector
to defend itself against inconsistent, unfair, or incorrect application of the law. A reformed judiciary
would also strengthen the fundamental system of checks and balances between the courts and public
administration, and allow the regulatory framework to learn from its mistakes, based on court rulings, as
in other market economies. Today, the perceived lack of recourse to courts leaves enterprises largely at
the mercy of the public administration, sustaining state capture and corruption, undermining confidence,
and thwarting development. The AA with the EU, which has a special focus on the judicial system, could
provide the much-needed trigger for fundamental reform.
11. Finally, political commitment is also vital. Economic history shows that the fate of countries
ultimately depends on their culture, value system, and quality of leadership. Even the best-designed
legislative frameworks crumble in the face of ill-intentioned implementation and “ways of doing things”,
which tend to be driven by ingrained social and political behaviors. The political leadership in Ukraine thus
needs to start by providing the much-needed signal to the whole society and to the public administration
in particular that business is no longer as usual, and that poor implementation of the law, administrative
neglect and corruption will no longer be tolerated. There is hardly any other way to start improving the
business climate in the long-term.
12. Curbing state capture and corruption requires an across-the-board consensus on reforms.
The strong political momentum stemming from the cross-party consensus on the need to sign the AA with
the EU should be sustained to support the adoption of the hundreds of pieces of legislation that would
accompany the EU agreements and to spur the overall private sector reform agenda. The consensus could
be strengthened by, for instance, establishing a national round table on reforms, which would include all
12
political parties, business community and civil society. Launching a comprehensive information campaign
directed at the public could also be useful to strengthen consensus on reforms.
13. Progress in the reform process can also hardly be envisioned without a much stronger civil
society. The current, relatively weak, involvement of civil society – especially NGOs representing small
and medium enterprises (SMEs) – in monitoring the business environment and driving the reform process
is an important obstacle to private sector development. In contrast to their large counterparts, which often
have sufficient resources to deal with the poor business climate, SMEs harbor a long-term interest in
improving the regulatory environment and investment climate, as it strongly affects their chances for
survival. However, SMEs lack resources that would help them channel their commitment to the reform
process and facilitate access to policy-makers. SME business associations are not strong, and they largely
focus on advising members on how to cope with the existing regulatory maze rather than on how to
improve it. Going forward, the contribution of SMEs to the public debate could be increased by including
them in working groups and/or national round tables dealing with the business environment. Similarly, the
impact of society at large on the reform process could be elevated by involving it in monitoring progress
in implementation of reforms by providing free and user-friendly on line public access to state-generated
performance statistics.
14. In sum, Ukraine needs a decisive breakthrough in improving the business climate to fully
realize its growth potential. Previous studies of the World Bank (2007, 2010) argue that Ukraine seems
to be trapped in a self-perpetuating low equilibrium, characterized by high barriers to market entry, low
competition, limited incentives for technology absorption, low export diversification and sophistication, and
high vulnerability to commodity prices. This vicious circle, sustained via poor contract enforcement, weak
property rights, and weak governance, needs to be broken for the country to achieve its growth potential.
15. The Association Agreement (AA) with the EU could provide an important anchor for the
reform process. Implementation of the AA, together with the Deep and Comprehensive Free Trade Area
(DCFTA) agreement, could carry substantial benefits for Ukraine. EU accession had such an effect earlier
for thenew EU members in Central and East Europe, which took advantage of the intimate engagement
with the EU to increase exports, attract FDI, enhance competition, minimize the negative influence of
vested interests, and ultimately make a historically unprecedented step towards catching up with the
West. The entrance of the EU agreements into full force would create legally binding obligations for the
harmonization of Ukraine’s laws with the regulatory architecture of the EU’s single market.
16. Robust implementation of the private sector development agenda will be key to kick-starting
the market from its current self-perpetuating low equilibrium. There is often a disconnect between
legislation and policy implementation that undermines the impact of the government’s reform efforts.
Hence, a radically new approach to the implementation of policy measures will be needed if Ukraine hopes
to reap the full benefits of the recent and planned reforms. This would require higher quality of legislation,
but also enhanced capacity and efficient monitoring of implementing institutions.
17. If the reforms recommended in the note were effectively implemented, the impact on Ukraine’s
GDP would be substantial. A 2006 IMF study (Tiff in 2008) suggests that based on the existing stock of
capital and labor, Ukraine’s income levels could nearly double if the country approximated the levels of
institutional and market efficiency common in EU10. Given that the institutional gap between Ukraine and
EU10 has not diminished much since the analysis was performed, the benefits of further business reforms
would still be substantial, helping to offset the time lost since the beginning of transition and boost income
convergence.
18. The Ukrainian government is aware of the above-mentioned challenges: the national reform
agenda is focused on promoting private sector development. The National Action Plan adopted
13
in March 2013 by the Ukrainian Cabinet of Ministers aims to spur private sector growth and enhance
export competitiveness. The Action Plan offers a list of 44 legal reforms to be enacted in the course of
2013, in areas such as regulatory policy, permits and licensing, investor protection, customs, inspections,
competition protection, administrative services, technical regulations, food safety, access to electricity, and
tax administration. A summary of the Action Plan is included in Annex 1. The Action Plan sets an explicit
objective of improving Ukraine’s Doing Business ranking from 140th place in DB 2013 to the top 100. Thanks
to a number of reforms enacted under the Action Plan, Ukraine has already moved to 112th place in DB 2014.
19. This note aims to inform the World Bank Group’s policy dialogue and technical assistance to
the Government in support of its private sector development reform efforts. Given the Government’s
ambitious plans for improving the business climate and competitiveness, the World Bank Group stands
ready to continue to support the Government in its reform attempts, building on existing cooperation with
the IFC and on-going policy dialogue led by the World Bank Group Doing Business team, in line with the
Bank Group’s Country Partnership Strategy.
20. The note is structured as follows. The first chapter traces the roots of the tepid private sector
growth. The following three chapters focus on the three main constraints to private sector development,
reviewing the Ukrainian market’s structural weaknesses in business regulation, access to finance, and
competition, and providing recommendations. The last chapter concludes. Table 1 below offers a summary
of key policy recommendations made in this note.
Table 1: Key Policy Recommendations: Regulation, Access to Finance and Competition
Suggested Short-Term Medium-Term
Reforms Recommendations Recommendations
Regulatory Implement a regulatory guillotine in line Implement the 2013 National Action Plan
Framework with international best practice, to allow on improving the business climate.
for a wholesale reduction in permits, li-
Strengthen the regulatory impact assess-
censes and redundant business regula-
ment (RIA), in line with international
tions.
practice, to increase the quality of new
Extend the scope of self-certification to legislation.
more business activities.
Harmonize technical and food safety
Finalize the inspections reform by intro- lations with EU regulations.
regu­
ducing afull-scale risk-based system, and
Finalize the institutional reform of the
adopt appropriate risk criteria and check-
technical regulations system.
lists across all inspectorates.
Ensure the effective implementation of
Eliminate mandatory certification for
the new insolvency law.
goods and services that do not require it
in line with EU and international practice. Improve the consultative process for new
legislation, including, for example, the
Improve the regulatory environment in
public posting of comments and responses.
the agrarian sector by eliminating the
compulsory certification of grains and Develop a comprehensive strategy for
grain storage and enhancing the transpa­ SME development in line with good in-
rency of policy implementation. ternational practice.
Implement further reforms measured by Introduce a broad range of e-government
the Doing Business ranking. and ICT solutions, including the online
registration of companies, online appli-
Enforce the law on public access to all
cations for permits and licenses, and an
documents related to business regula-
Internet based library of all business re-
tions, including proposed drafts and reg-
lated requirements.
ulatory impact assessments.
14
Suggested Short-Term Medium-Term
Reforms Recommendations Recommendations
Access Gradually transition to a flexible ex- Review constraints on foreign exchange
to Finance change rate, and tighten fiscal policy. lending and set appropriate prudential
limi­tations.
Encourage longer-term savings by more
strictly distinguishing demand and time Enforce legislation on disclosure of the
deposits and potentially expanding de- ultimate beneficiaries of banks, apply
posit guarantee coverage to include cer- consolidated supervision, identify and
tificates of deposit issued by banks to limit related party lending.
their clients.
Increase depositor confidence by intro-
Approve laws removing tax disincentives ducing market conduct regulation, ap-
for NPL transfer and write-offs. pointing a financial ombudsman, and
improving financial consumer protection
Expedite and reduce costs of access to
rules and industry standards.
the State Registry of Encumbrances over
Immoveable Assets. Approve legislation completing the con-
solidation of information on credit his-
Pass legislation allowing dual listings of
tories and introduce a minimum unified
Ukrainian companies that are currently
standard for information on the credit
listed in foreign jurisdictions.
history.
Remove constraints to Hryvnia-denomi­
Enact and enforce further legal and regu-
nated lending by IFIs by reconsidering
latory reforms to improve capital market
the interest rate cap imposed by the NBU.
transparency, protect investors’ rights,
and enhance disclosure requirements.
Enact legislative and regulatory reforms
improving reporting standards, and en-
hancing transparency and corporate go­
vernance in Ukrainian firms, including
SMEs.
15
Suggested Short-Term Medium-Term
Reforms Recommendations Recommendations
Competition Amend the Commercial Code to elimi- Pass legal amendments to harmonize
nate conflicts with competition laws. Ukraine’s competition legislation with
that of the European Union.
Enact the Law on State Aid to Business
Entities and implement an effective sys- Strengthen the de facto political indepen-
tem for controlling anticompetitive state dence of the AMC.
aid, as per the commitments in the EU
Improve co-operation with other
Association Agreement.
Ukrainian law enforcement agencies and
Increase the AMC’s investigative power investigative bodies.
and capacity to collect evidence of wrong
Clarify court jurisdiction for competition
doing.
cases.
Modify merger/concentration notifi-
Provide adequate resources to ensure that
cation and abuse of dominant position
the AMC can maintain high standards of
thresholds to focus on transactions likely
performance in accomplishing its mis-
to raise competitive concerns, including
sion.
those involving entities concealing ulti-
mate owners. Reduce the burden on the AMC in areas
that should not belong to its core activi­
Improve procedures for imposing and
ties such as natural monopolies, public
collecting monetary penalties imposed
procurement and trademarks.
by the AMC.
Complete the institutional reform of
Amend the leniency program to allow le-
AMC as outlined in the draft Law on
niency for more than one applicant.
“National Competition Program 2014-
Strengthen competition advocacy activi- 2024”.
ties and outreach to the public.
Expand the use of market studies to better
monitor levels of competition.
16
Chapter I: The Private Sector Growth Problem
Summary
21. This chapter argues that the stunted growth of the private sector goes a long way in
explaining Ukraine’s poor economic performance. The stunted growth is reflected in the generally
stagnant structure of GDP, domestic production and exports, where old industries such as steel, machine
building and chemicals continue to dominate; modest growth and low levels of industrial productivity,
which has grown at a slower pace than in peer countries in the past decade; low inflow of high-value added
FDI, especially in export-oriented manufacturing; high energy inefficiency; and the relatively limited role
of SMEs in the development of the economy. All of these factors suggest that the market-driven process
of entrepreneurial self-selection and self-discovery does not seem to work properly, and thus undermines
Ukraine’s growth prospects.
Introduction
22. At the beginning of transition, Ukraine had a number of strengths, which seemed to predict
a successful transition to a market economy and a gradual increase in living standards. It had fertile
agricultural lands, an attractive geographical location in Europe at the crossroads between the West and the
East, a large domestic market of almost 49 million consumers, abundant natural resources, relatively well-
developed infrastructure, high-quality human capital, and a significant industrial base in the east of the
country, featuring global technology leaders such as the Antonov aviation company, which manufactured
the largest airplane in the world.
23. Yet, the economic miracle did not materialize. Ukraine’s GDP per capita lingers below 1989
levels and at a mere 10 percent of the European Union average after twenty years of transition. Incomes
have increased much more slowly in Ukraine than in the Europe and Central Asia (ECA) region as a whole
(Figure 1). Ukraine has also been under performing relative to regional peers, such as Poland, Romania,
Russia and Belarus (Figure 2), including during the ongoing global crisis. Despite similar starting points at
the beginning of transition, Poland’s and Ukraine’s income levels have diverged over the years. Incomes in
neighboring Poland, arguably the most successful economy in Europe since 1989 (Piatkowski 2013), are
now almost four times higher than in Ukraine. Growth projections suggest that the income gap between
Ukraine and these peers will not be closed in the short term.1
1
In 2013, GDP growth in Ukraine and Poland, for instance, is projected at around 0 percent and 1.3 percent,
respectively.
17
Figure 1: GDP Growth in Ukraine and ECA, 1990-2013, 1990=100
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Source: World Bank, ECA Regional Tables.
Figure 2: GDP per Capita in PPP, Constant 2005 International $
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Source: World Bank, ECA Regional Tables.
24. Ukraine was one of the economies most severely hit by the global crisis. Real GDP declined by
15 percent in 2009, much more than elsewhere in the region. While the economy regained some steam in
2010-2011, the GDP growth rate declined again in 2012, dropping close to zero. It is projected to stagnate
around 0 percent in 2013 and slightly pick to 2 percent in 2014, well below Ukraine’s potential.
18
Figure 3: Real GDP Growth Rate, 2008-2013
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Source: World Bank, ECA Regional Tables, and projections for 2013.
25. The stunted growth of the private sector is among the key reasons for Ukraine’s poor
economic performance. Evidence of this structural problem is abundant: the stagnant structure of the
country’s exports; the low growth rate and overall level of productivity; the low inflows of FDI, particularly
in export-oriented manufacturing; high energy intensity; and the relatively small share of SMEs in GDP.
Each of these factors is documented in more detail below.
26. Ukraine’s productivity lags its regional peers. In 1996-2011, labor productivity growth (GDP
per person employed) was lower than in comparator countries (Figure 4). As a result, Ukraine’s level
of productivity in 2012 amounted to only 16 percent of the level of productivity in the US (Figure 5).
Importantly, Ukraine has done even worse when it comes to Total Factor Productivity (TFP) growth.
In 2006-2010, growth rates were actually negative. In the earlier period of 1996-2005, Ukraine’s TFP
growth amounted to the rather weak 1.7 percent per year (Figure 6). Such slow growth in TFP suggests
that Ukraine’s labor productivity growth was largely based on increases in capital investment, rather than
improvements in “pure” productivity driven by higher-quality human capital, enhanced business practices,
and faster technology absorption. In other words, Ukraine experienced “extensive” rather than “intensive”
growth, unlike most of its peer countries, where TFP growth was the predominant source of development
and economic convergence. Inefficient use of the existing, and relatively abundant, capital is also evident
in Figure 7, where Ukraine lags regional and global peers.
19
Figure 4: Labor Productivity Growth in Ukraine and Selected Countries, 1996-2011
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Note: sorted by 2006-2011
Source: Bank staff calculations based on the Conference Board’s Total Economy Database, January 2013.
Figure 5: GDP per Person Employed, US=100, 2012
80%
70%
60%
50%
40%
30%
20%
10%
0%
Europe Poland Russia Belarus World Romania Ukraine
Source: Bank staff calculations based on the Conference Board’s Total Economy Database, January 2013.
20
Figure 6: Total Factor Productivity Growth, 1996-2010
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Source: Bank staff calculations based on the Conference Board’s Total Economy Database, January 2013.
Figure 7: Total Factor Productivity Levels Relative to the Global Production Frontier, 2010
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